By Julie Sloane 10.26.07
When a startup shows an approximate $150 000 000 in revenue, isn’t wildly profitable, and doesn’t have a clear revenue model, no company in its right mind would give it a $15 billion valuation — except, it seems, if we’re talking about Facebook.
Could Facebook defy business norms? Could it really be worth enough to give its founder, a 24-year-old Mark Zuckerberg, a fortune estimated at between $3 billion and $5 billion? It all depends on the company’s success at building an advertising network, details of which the company is expected to announce on November 6.
With all the dreamy-eyed developers and enraptured tech evangelists filling Silicon Valley with their Facebook love, it’s important to remember that the $15 billion figure is fairly abstract. Microsoft was ready to give $240 million for a 1.6% part of Facebook, but it’s debatable whether subsequent investors will see things the same way. In this case, Microsoft had compelling reasons to yield to Facebook’s terms.
For one thing, $240 million is chump change to Microsoft, which has $6.6 billion cash in the bank. Greg Sterling, both an independent consultant and a senior analyst for advisory service Local Mobile Search, frames it this way: Microsoft wanted to completely block Google from affecting its already established advertising relationship with Facebook. It also couldn’t afford to lose perceived momentum with its biggest advertising partner.
While advertising is an important business to Microsoft, their CEO Steve Ballmer has openly stated that digital advertising will be 25 % of Microsoft’s toal revenue within a couple of years – at the moment it is a major let down, and is the only significant part of Microsoft that is losing money. The Microsoft’s Online Services Business, which comprises of digital advertising, Live Search, MSN Hotmail and Messenger, showed a net loss of approximately $262 million in the most recent quarter. Its combined revenues of $671 million represented just 5 % of the company’s quarterly total. The loss in such a hyped area of the business was a conspicuous blemish in an otherwise dazzling quarter.
“Microsoft was paying to maintain the relationship on terms that were very favorable to Facebook,” says Sterling, “and Facebook was in a position to negotiate that sort of valuation, because it had competitive bidders.”
So what will it take for Facebook to reach the point where a suitor might actually pay $15 billion for it? Facebook has earned its valuation based solely on the market’s expectations, and those are quite high. Sustained growth will be most important.
Today Facebook has approximately 50 million users. Most people believe that the number can increase to between 200 and 300 million in the near future. Just the single fact that Facebook is doubling its user-base every 6 months looks well for the future, says Dave McClure a startup advisor and investor. But whether Facebook can convert those users into cash remains the burning question. “If they can accomplish that, then there’s probably an even richer valuation than $15 billion,” he says.
Much is riding on Facebook’s upcoming ad network. “The most important fact is that Facebook has an established audience,” says Charlene Li, a Forrester analyst. “Wherever big audiences choose to spend time, it quickly becomes a significant advertising medium.” Presumably Facebook will use its wide ranging user data to offer advertising targeted on an individual level.
A big challenge for Facebook is like to be the fact that most users of social networks usually click on ads much less than, for example, search-engine users do. But Li points out the big money is in ads which put a brand in front of impressionable consumers. The more information Facebook can offer to brand advertisers — for instance on how certain demographics behave — the more valuable the platform could become.
At the SNAP Summit in San Francisco Friday, Altura Ventures CEO Lee Lorenzen suggested another intriguing possibility: a shopping mall application that would allow users to curate their own “shop,” effectively bringing online commerce to Facebook. “It’s not rocket science to put together a bunch of merchants in one shopping cart,” says Lorenzen. “As soon as that happens and Facebook trains users to put their credit cards into their platform, commerce could take off for the site.”
The whole endeavor is risky. Social networks are largely about entertainment, not utility. “Much of that activity is tied up in the notion of being at the hip, cool party,” says Sterling. “If the party gets less happening, people will move on. There’s a perishable quality to the audience.” Sterling muses that Microsoft may want to embed its Live Search into Facebook, giving it more users and making Facebook more useful.
And Facebook’s competitors have deep pockets. Facebook has the media buzz, but MySpace has more than double the number of users. According to a report by research firm eMarketer, Myspace currently has 58 percent of the ad market and Facebook just 14 percent. Google’s ambitions to grow its own social network, Orkut, are much rumored. Google’s track record, you might say, doesn’t suck. It’s shown an ability to monetize users, but it needs to attract them first.
Right now the weight on Mark Zuckerberg’s shoulders is to keep the party going while offering a sustainable revenue model that goes beyond the current banner ads and $1 virtual gifts. He’s the $3 billion man . . . at least until November 6.